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Lecture 2.

The External
Environment
(Macro environment)

Lecture Two: Overview

A business organization is also influenced by certain forces and institutions
operating from outside. These constitute the external environment of business.
A business is influenced both collectively and individually by these factors.
The external environment of business can be divided into micro- and macro-
environment.
The micro-environment includes the general public, customers, suppliers of
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input, workers along with trade unions, market intermediaries, competitors and
the public whose decisions and actions have a direct impact on the functioning
of a company. (These we have covered)

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The Macro Environment: Overview

In this lecture, we delve deeper in each macro factor in order to appreciate the
extent to which they affect business performance and strategic management.
The macro-environment of business consisting of both economic and non-
economic environments is of great strategic importance. It is this
environment that is likely to determine to a great extent the success or

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otherwise of business.

The Macro Environment: Overview

The Economic Environment Non-Economic Factors

1. Economic Systems 1. Social,
2. Economic Policies 2. Political-Legal,
3. Economic Conditions 3. Technological,
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4. Demographic, and
5. Natural Environment

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1: The Economic Environment

1. The Economic Systems
• The economic system that has been adopted in a country is basically influenced
by the philosophy, history, aspirations and attitudes of its people and the system
they want to put in place to translate these factors into realities and fulfil their
chosen ideals and goals.
• The nature of an economic system relies on the agencies which are permitted to
own and put to use the productive resources, extent of individual’s initiative

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permitted in the economic activity, types of incentives offered to employees and
the process of price determination.

• If we analyse the features of the present economic systems prevalent in the

world, namely: free- enterprise, socialism and mixed economy systems
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1: The Economic Environment

1. The Economic Systems
• In all economies, irrespective of their political and social affiliations, resources are
scarce. Individual firms and the state have to make rational choices to put them to best
uses.
• All economies (capitalist, socialist or mixed), face the same economic problems such as
what to produce, how to produce, for whom to produce, when to produce, the quality
and quantity of goods to produce and how to make them available to ultimate
consumers.
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1. Free- enterprise: Limited to no state intervention in resource allocation. The market

regulates itself.
2. Socialism: Relatively high influence of the state in resource allocation
3. Mixed economy: Markets allowed to thrive alongside a relatively visible intervention of
the state in resource allocation.
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1: The Economic Environment

1. The Economic Systems
• Economic systems all over the world while being implemented have
undergone vast changes, so much so that none of the economic systems
prevalent today can be said to be as pure as it was adumbrated or envisaged
by its promoters
(i) In most economies, both free market pricing and centralized planning

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coexist in different degrees. Even in the most ardent free market
societies, government tries to regulate prices of products which are in
short supply so as to help alleviate the sufferings of the poor and
impoverished sections of the society.

1: The Economic Environment

1. The Economic Systems
(ii) Almost in all economies, be they capitalist, socialist or mixed, positive
government intervention is on the rise. Economic planning, too, is a
government intervention. Though for a very long time the role of the
State in regulating private enterprise was looked down with suspicion,
certain developments in recent times have made government
intervention in economic matters absolutely essential and is being
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desired by the very same private sector industry which normally does not
favour the State playing a big brother’s role

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1: The Economic Environment

2. The Economic Policies
Banking and Monetary Policy: Business firms in a dynamic and growing economy
would face the problems of credit requirements in the form of liquid capital. To
achieve efficiency, industrial and commercial establishments must have
adequate working capital in appropriate amounts made available at the
appropriate time.

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This requires rationing of scarce monetary resources to the enterprises. A similar
problem is the control of money supply in the economy so that there is neither
too much nor too little of it at anytime.

1: The Economic Environment

2. The Economic Policies
Fiscal Policy: is a policy dealing with the revenue and expenditures of the
government to achieve certain socio-economic objectives including the
realization of a redistributive effect.
The fiscal policy which is being handled by the Finance Ministry affects the
policy through the exercise of annual budgets. The national budget is a basic
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instrument of governmental fiscal policy in all countries. The role of the budget
is to allocate funds and transfer resources in accordance with the government’s
overall socio-economic objectives from one area of the economy to another.
When the government spends too much in certain sectors of the economy and
too little in others, serious imbalances may arise
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1: The Economic Environment

3. The Economic Conditions
Economic and Price Stability: are two of the most important parameters that
reflect the long-term equilibrium of an economy. Economic stability is a
condition of comparatively fuller utilization or the avoidance of abrupt and
major disruptions in the employment of the country’s available productive
resources.

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Price stability refers to a situation where prices are relatively stable over time. If
prices rise gently, say, between one per cent and three per cent, generally
referred to as “creeping inflation”, it is said to help business in as much as
consumers are not dissuaded from purchasing goods while producers stand to
gain by the marginal increase in prices.
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1: The Economic Environment

3. The Economic Conditions
Money and Capital Market: The growth and maintenance of a well-developed
money market is a sine qua non for orderly functioning of industrial and
commercial organizations that require working capital for their short-term
requirements.
In Uganda, commercial banks and non-banking finance companies deal in short-
term funds and help industries finance short-term projects. However, the
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Ugandan money market is characterized by a dichotomy in their structure. We

have relatively a small number of well organized Western type commercial
banks whereas there are thousands of unorganized money lenders who charge
usurious rates of interest and play their roles in financing agriculture and small
scale industries.
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1: The Economic Environment

3. The Economic Conditions
Size of the Market: It is said that division of labour is limited by the size of the
market and vice versa. If a country’s size of the market is too small, firms will not
come forward to invest in them.
If several multinationals are willing to come and invest in Uganda, it is because
Uganda has a virgin market with a relatively increasing population. Many more

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multinational producers of consumer durables, especially from China and
Europe have come and established their industries in IUganda because of the
ever growing number of consumers belonging to the middle income group.

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1: The Economic Environment

3. The Economic Conditions
Size of the Market: It is said that division of labour is limited by the size of the
market and vice versa. If a country’s size of the market is too small, firms will not
come forward to invest in them.
If several multinationals are willing to come and invest in Uganda, it is because
Uganda has a virgin market with a relatively increasing population. Many more
Copyright (c) 2020 John Wiley & Sons, Inc.

multinational producers of consumer durables, especially from China and

Europe have come and established their industries in Uganda because of the
ever growing number of consumers belonging to the middle income group.

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1: The Economic Environment

3. The Economic Conditions
External Trade/International Environment: Foreign trade is one of the important
constituents of a country’s economic environment. Though the Ugandan economy is
exposed to international trade only to a limited extent compared to developed
countries, it is still important to the growth of the economy and to meet the current
needs of essential products such as fuel, fertilizer, and industrial parts.
The primary function of foreign trade is to: (i) procure plant and machinery; (ii)

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facilitate the flow of technology; (iii) boost the domestic economy by encouraging
competition through high quality low priced imported goods; (iv) help in the full
utilization of domestic resources; (v) promote workers’ and consumers’ welfare; and
(vi) the reduction of poverty and promote prosperity among people and communities
associated with exports and imports of commodities.
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2: The Non-Economic Environment

If the business community should be aware of the forces that constitute the
economic environment of business, being conscious of the forces of non-
economic environment of business is also equally important for them to take
successful business decisions.

For this, it is necessary to identify the factors that constitute non-economic

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environment as they influence the economic environment and in turn are

influenced by it.

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2: The Non-Economic Environment

1. The Socio-cultural Environment: Social environment describes the people,
their attitudes, social behaviour and impact of education, knowledge
explosion and public opinion whereas cultural environment deals with
values, norms and accepted behavioural patterns.
• A business must adjust its methods of operations with changing socio-cultural
values. A person’s interaction with the society he/she lives in shapes, refines
and even alters his/her beliefs, values and norms which in turn define his/her

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tastes and preferences and even prompts him/her to absorb a world view of
things. This process defines his/her relationship to his/her own self and
others in the society, institutions, nature of the society and to the universe
itself.
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2: The Non-Economic Environment

1. The Socio-cultural Environment:
• In a social group, cultures and subcultures intermingle and sometimes
tend to lose their uniqueness and individuality.
• In Uganda, for instance, there are six major religions, more than 100
cultures and languages, all of which have some impact or the other on
people living in the respective regions.
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• Differences in religion, language, customs, habits, values and social

systems are a legion and make Uganda’s socio-cultural environment both
unique and complex. The social-cultural environment shapes the
attitudes of human beings.
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2: The Non-Economic Environment

2. The Educational Environment: Educational environment in a country
influences every aspect of managerial and industrial life. There are six basic
educational inputs which are of interest to the firms and to the country. They are
as follows:
(i) Illiteracy is closely correlated to poverty. It is extremely difficult to get
and hold on to a job without, at least, the ability to read and write.

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(ii) There is a close relationship between education and income. Graduates
earn more than, say, a school or college dropout.
(iii) University and college training is generally useful to firms. Many kinds
of highly skilled or specialized jobs cannot be per- formed with, if at all,
by persons without appropriate training.
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2: The Non-Economic Environment

3. The Politico-legal Environment:
The politico-legal environment provides the legal framework within which
business can function. They are essential for the orderly conduct of business.
• Political environment describes the political system prevailing in the country
and also deals with the regulations and legislations pertaining to business
operations, government programmes, war, election, and similar other
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problems.
• By political-legal environment is meant the situation and circumstances
relating to the government, politics and public affairs of a country. They also
relate to the laws, the government agencies that implement them and
pressure groups that influence and limit various organizations and individuals.
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2: The Non-Economic Environment

3. The Politico-legal Environment:
There are as many legal systems as there are countries, and in many cases, states,
cities or provinces also have their own laws. The politico-legal constraints deal more
with the activities and decisions of the firms. Laws may prevent firms from doing
something or require them to do something else.
• Foreign policy has a critical impact on industrial management and international

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business in developing countries. A developing country may strongly need foreign
investment, know-how, technology and imports but it may have serious
reservations and suspicions about foreign influence and control.
• A high degree of political stability over a period of time does assure a high degree
of industrial progress and business thrive.
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2: The Non-Economic Environment

4. The Demographic Environment:
The population of a country with its characteristics such as: the population size and
growth rate, age structure and composition, gender composition, life expectancy,
work participation rate, employment status, rural–urban divide, levels of education,
ethnicity, language and religion have a huge impact on its business. This is because
people are both consumers and producers, two of the most important constituents
in a business environment.
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• Demographics are analyzed on a global basis because of the potential effects

across borders and because many firms compete in global markets.

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2: The Non-Economic Environment

5. The Technological Environment:
The Technological factors are variables which relate to the existence, availability,
and development of technology. This could include things from computational
power to engine efficiency.
It might be unclear how technological factors can directly affect business, unless
you take a step back and look at all of the technology that’s used in day-to-day

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life.
Think about the machines which are used to print on the t-shirts you buy, the
computer servers which are used to keep up the website(s) you own, or the fuel
used to power the car(s) you drive. Technology hugely dictates the way many
things are done, in business or otherwise.
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2: The Non-Economic Environment

5. The Technological Environment:..
General examples of Technological Factors affecting business include:
• Automation — The automation of many unskilled tasks can allow companies
to replace human production lines with entirely machine ones. This can reduce
costs for manufacturers, distributors, supermarkets, and many other different
businesses..
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• Internet connectivity — It’s undoubtable that in recent years global internet

connectivity has been on the rise. This presents an even larger market for
many companies who use the internet to connect with their customers. A
global rise in internet connectivity might has reduced lags in communication
creating an efficient global business environment.
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2: The Non-Economic Environment

5. The Natural Environment:
The natural environment in which a business exists includes ecological and
geographical factors that may influence its activities. Natural factors like
geography, climatic conditions, the availability of resources, air quality and
environmental regulations greatly affect the functioning of a business.
It is a key macro aspect that ultimately determines how the business interacts

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with inputs like raw materials and if the output is conducive to its natural
environment at large.

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Industry Environment Analysis

• An industry is a group of firms producing products that are close substitutes.
• To be successful in any business, the ecosystem or the environment of business,
industry, geography, trends should be well understood. To understand this, proper
study and analysis of the industry environment has to be performed.
• The major objectives of such industry environment analysis are:
v To identify key success factors of that industry
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v To assess attractiveness and growth prospects for entry

v To formulate competitive strategy
v To study changes over time and predict trends

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Industry Environment Analysis

• An industry is a group of firms producing products that are close substitutes.
• To be successful in any business, the ecosystem or the environment of business,
industry, geography, trends should be well understood. To understand this, proper
study and analysis of the industry environment has to be performed.
• The major objectives of such industry environment analysis are:
v To identify key success factors of that industry

Copyright (c) 2020 John Wiley & Sons, Inc.

v To assess attractiveness and growth prospects for entry
v To formulate competitive strategy
v To study changes over time and predict trends

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Industry Environment Analysis

The Structure-Conduct- Performance
• The structure–conduct–performance (SCP) looks at the causal relationship
between the structure of an industry, firm conduct and market performance. It
provides a framework for industry situation analysis as it maps relations among
market structure, market conduct, and market performance thus providing a
complete understanding of current industry structure, players, conduct and their
competitive performance over time.
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• In the S-C-P paradigm, an industry's performance – the success of an industry in

producing benefits for consumers – depends on the conduct or behaviour – of
sellers and buyers, which depends on the structure of the market. The structure, in
turn, depends on basic conditions such as technology and demand for a product.
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Industry Environment Analysis

The Structure-Conduct- Performance
• Structure: is the set of conditions and characteristics that describe and define
the market type.
• To describe market structure, economists consider the number and size
distribution of firms, the extent of product differentiation, the effectiveness of
barriers to entry, and the degree to which the industry is vertically integrated.

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• The key things defined by structure are:
v Number of firms in the industry (Extent of competition)
v Extent of product differentiation
v Barriers to Entry
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Industry Environment Analysis

The Structure-Conduct- Performance
Market Structures:
Copyright (c) 2020 John Wiley & Sons, Inc.

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Industry Environment Analysis

The Structure-Conduct- Performance
• Conduct: the behaviour, policies, and strategies used by the firms in the industry.
To describe firms’ conduct, economists consider the strategies used by firms as
they affect pricing, production, promotion, and distribution. It also refers to the
strategies that firms in an industry implement

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• Performance: refers to the economic outcomes that result from the market
structure and the firms’ conduct. To evaluate an industry’s performance,
economists consider allocation efficiency, production efficiency, equity, and
technological advancement.

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Industry Environment Analysis

The Structure-Conduct- Performance Copyright (c) 2020 John Wiley & Sons, Inc.

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Industry Environment Analysis

The Structure-Conduct- Performance
• The logic that links industry structure to conduct and performance is well known.
– Attributes of the industry structure within which a firm operates define the
range of options and constraints facing a firm.
– In some industries, firms have very few options and face many constraints.
– In general, firms in these industries can only gain competitive parity. In this

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setting, industry structure completely determines both firm conduct and
long-run firm performance

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Industry Environment Analysis

• An industry is a group of firms producing products that are close substitutes.
• To be successful in any business, the ecosystem or the environment of business,
industry, geography, trends should be well understood. To understand this, proper
study and analysis of the industry environment has to be performed.
• The major objectives of such industry environment analysis are:
v To identify key success factors of that industry
Copyright (c) 2020 John Wiley & Sons, Inc.

v To assess attractiveness and growth prospects for entry

v To formulate competitive strategy
v To study changes over time and predict trends

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Industry Environment Analysis

• The industry environment is composed of the following stakeholders, around
which analysis is done. Namely:
v Competitors,
v Suppliers and
v Buyers.

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• To analyse these aspects of the industry, models such as PEST/PESTEL, and
PORTER’s 5 forces have been developed.
• A successful industry environment analysis will tell about the important factors like
customers, suppliers/vendors, competitive landscape etc. which is critical for
business success.
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Competitive Structure of Industries

The competitive structure of industries is a very important business environment.
Identification of forces affecting the competitive dynamics of an industry will be very
useful in formulating strategies.
According to Michael Porter’s well-known model of structural analysis of industries,
the state of competition in an industry depends on five basic competitive forces, viz.,
1. Rivalry among existing firms
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2. Threat of new entrants

3. Threat of substitutes
4. Bargaining power of suppliers
5. Bargaining power of buyers.
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Competitive Structure of Industries

The figure depicts the five forces
competitive structure of industry.
The diagram is a slightly modified
presentation of the one provided by
Porter.

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The arrows in the diverse directions
indicate opposing forces. For
example, just as the buyers has
bargaining power over the firm, the
firm also has some bargaining
power over the buyers Fig. Forces Driving Industry Competition 37

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Competitive Structure of Industries

Threat of Entry
A growing industry often faces threat of new entrants that can alter the competitive
environment. There may, however, be a number of barriers to entry. Potential
competition tends to be high if the industry is profitable or critical, entry barriers
are low and expected retaliation from the existing firms is not serious.
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The following are some of the important common entry barriers:

1. Government Policy: In many cases, government policy and regulation are
important entry barriers. For example, prior to the economic liberalisation,
government- dictated entry barriers, industrial licensing, import restrictions,
restrictions on foreign capital and technology etc.
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Competitive Structure of Industries

Threat of Entry
The following are some of the important common entry barriers:
2. Economies of Scale: Economies of scale can deter entry in two ways: it keeps
out small players and discourages even potentially large players because of the
risk of large stakes.
3. Cost Disadvantages Independent of Scale: Entry barrier may also arise from the

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cost advantages, besides that of economies of scale, enjoyed by the established
firms which cannot be replicated by new firms, such as proprietary product
technology, learning or experience curve, favourable access to raw materials,
favourable location, government subsidies etc.

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Competitive Structure of Industries

Threat of Entry
The following are some of the important common entry barriers:
4. Product Differentiation: Product differentiation characterised by brand image,
customer loyalty, product attributes etc. may form an entry barrier forcing new
entrants to spend heavily to overcome this barrier.
5. Monopoly Elements: Proprietary product/technology, monopolisation/effective
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control over raw material supplies, distribution channels etc. are entry barriers
which are insurmountable or difficult to overcome.
6. Capital Requirements: High capital-intensive nature of the industry is an entry
barrier to small firms. Further, the risk of huge investment could be a
discouraging factor even for other firms.
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Competitive Structure of Industries

Rivalry among Existing Competitors
Rivalry among existing competitors is often the most conspicuous of the
competitions. Firms in an industry are “mutually dependent” – competitive moves
of a firm usually affect others and may be retaliated. Common competitive actions
include price changes, promotional measures, customer service, warranties,
product improvements, new product introductions, channel promotion etc.

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• There are a number of factors, which influence the intensity of rivalry. These
include:
1. Number of Firms and their Relative Market Share, Strengths etc.: Rivalry is
likely to be affected by the number firms, their relative market shares,
competitive strengths, etc.
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Competitive Structure of Industries

Rivalry among Existing Competitors
There are a number of factors, which influence the intensity of rivalry include:
2. State of Growth of Industry: In stagnant, declining and, to some extent, slow
growth industries, a firm is able to increase its sales only by increasing its
market share, i.e., at the expense of others.
3. Fixed or Storage Costs: When the fixed or storage costs are very high, firms
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are provoked to take measures to increase sales for improving capacity

utilisation or reducing storage costs.
4. Indivisibility of Capacity Augmentation: Where there are economies of
scale, capacity increases would be in large blocks necessitating, in many
cases, efforts to increase sales to achieve capacity utilisation norms.
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4. Competitive Structure of Industries

Rivalry among Existing Competitors
5. Product Standardisation and Switching Costs: When the product of
different firms are standardised, price, distribution, after-sales service,
credit etc. become important strategic variables of competition. Absence of
switching costs makes firms more vulnerable.
6. Strategic Stake: Rivalry in an industry becomes more volatile if a number of

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firms have high stakes in achieving success there. For example, a firm which
regards a particular industry as its core business will give great importance
to success in that industry.
7. Exit Barrier: High exist barriers (for example, compensation for labour,
emotional attachment to the industry etc.) tend to keep firms competing in
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Competitive Structure of Industries

Rivalry among Existing Competitors
8. Diverse Competitors: Rivalry becomes more complex and unpredictable
when competitors are very diverse in their strategies, origins,
personalities, relationships to their parents etc.
9. Switching Costs: In some cases, a barrier to entry is created by switching
costs (i.e., one- time costs facing the buyer of switching from one
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supplier’s product to another’s) such as cost of retraining the employees,

cost of new ancillary equipment etc.
10. Expected Retaliation: The potential entrants’ expectations about the
reactions of the existing competitors may also sometimes deter entry.

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Competitive Structure of Industries

Threat of Substitutes
An important force of competition is the power of substitutes. “Substitutes limit the
potential returns in an industry by placing a ceiling on the price firms in the industry
can profitability charge. The more attractive the price performance alternative
offered by substitutes, the firmer the lid on industry profits.”

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Porter points out that substitute products that deserve the most attention are those
that are:
(1) subject to trends improving their price-performance trade-off with the
industry’s product, or
(2) produced by industries earning high profits. 45

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Competitive Structure of Industries

Bargaining Power of Buyers
For several industries, buyers are potential competitors – they may integrate
backward. Besides, they have different degrees of bargaining power. “Buyers
compete with the industry by forcing down prices, bargaining for higher quality or
more services, and playing competitors against each other – all at the expense of
industry profitability”.
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Important determinants of the buyer power, explained by Porter, are the following:
1. The volume of purchase relative to the total sale of the seller.
2. The importance of the product to the buyer in terms of the total cost.
3. The extent of standardisation or differentiation of the product.
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Competitive Structure of Industries

Bargaining Power of Buyers
Important determinants of the buyer power, explained by Porter, are the following:

4. Switching costs.
5. Profitability of the buyer (low profitability tends to pressure costs down).

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6. Potential for backward integration by buyer.
7. Importance of the industry’s product with respect to the quality of the
buyer’s product or services.
8. Extent of buyers’ information.
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Competitive Structure of Industries

Bargaining Power of Suppliers
The important determinants of supplier power are the following:

1. Extent of concentration and domination in the supplier industry.

2. Importance of the product to the buyer.
3. Importance of the buyer to the supplier.
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4. Extent of substitutability of the product.

5. Switching costs.
6. Extent of differentiation or standardisation of the product.
7. Potential for forward integration by suppliers.

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Competitive Structure of Industries

Porter’s analysis, thus, shows that “Knowledge of these underlying sources of
competitive pressure highlights the critical strengths and weaknesses of the
company, reflects its positioning in its industry, clarifies the areas where strategic
changes may yield the greatest payoff, and highlights the areas where industry
trends promise to hold the greatest significance as either opportunities or threats.

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Understanding these sources will also prove to be useful in considering areas for
diversification, though the primary focus here is on strategy in individual industries.
Structural analysis is the fundamental underpinning for formulating competitive
strategy.

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